Tobacco Stocks' Double Benefit: Performance and Dividend

Tuesday, 20 Jul 2010 | 4:12 PM ETCNBC.com

SHARES

A lot of investors are chasing yields right now, and there aren't many places to boost returns. Bond yields are at historic lows, and a lot of growth companies are sitting on cash and not returning it to shareholders.

And you probably already own a decent-yielding blue chip.

So, why not look at cigarette companies?

"Tobacco stocks year-to-date have outperformed the market by 600 basis points," said Nik Modi, who covers U.S. tobacco names for UBS . "Altria, which is our top pick, has outperformed by 1300 basis points, even with the backdrop with all that's going on in the economy, with all the discussion about taxes and headwinds.

"In an environment of risk aversion, tobacco tends to do well because of their dividends."

Take a look for yourself. Altria , which reports earnings on Wednesday, has been up about 8 percent year-to-date and has a dividend yield above 6.5 percent.

Reynolds American and Phillip Morris report on Thursday and tell a similar story: Outperformance in equity markets and annual yields above the 10-year treasury. Modi also recommends Lorillard even though its stock has bucked the cigarette trend and traded down for the year.

"Let's just assume that these stocks don't move at all. You basically get a 7 percent return for the year because that's what the dividend yield for Altria is for instance," said Modi. "The market is up half that, so even without these stocks appreciating, you can still generate more than the market."

Tobacco Earnings Preview

A look ahead to earnings announcements from Altria, Reynolds American, Phillip Morris International and Lorillard, with CNBC's Brian Shactman.

But the question is: Can new money be put to good use in this space?

"We think in spite of the out-performance, we still see a lot to come," Modi said.

Beyond dividend yield, there are things to look closely at when studying their earnings.Keep an eye on where the global growth is, and which companies have the best exposure.

And Modi says, ignore the declining sales numbers in the U.S. It's all about pricing power, and believe it or not, cigarette companies have had it in recent quarters.

"That's why I'm saying pricing really matters right now and that's what the investment community should be watching for during earnings," said Modi.